This Company Could Be On the Leading Edge of the Defense Industry
Investors are sometimes required to consider news stories from different angles. One example of that is in the defense industry. A new contract in that sector could mean a company is maintaining its operations or it could signal that a company is advancing technology.
This industry could, in fact, be a bellwether for the broader tech sector. Many advances in consumer electronics, including the internet, began as developments in the defense sector. That’s why it is important for investors to read the news from the defense sector and consider the implications beyond defense.
A New Contract Signals Potential Leadership
A recent contract award, as GlobeNewswire reported, could show this smaller company could be at the leading edge of the cybersecurity industry.
“Mercury Systems, Inc. (Nasdaq: MRCY) announced it received a $3 million order from a leading defense prime contractor for rugged servers to be used in an Army communications application. The order was booked in the Company’s fiscal 2019 third quarter.”
Traders seemed to cheer the news.
“Mercury Systems is a leading commercial provider of secure sensor and safety-critical processing subsystems. Optimized for customer and mission success, Mercury’s solutions power a wide variety of critical defense and intelligence programs.
Mercury is pioneering a next-generation defense electronics business model specifically designed to meet the industry’s current and emerging technology needs.
A leader in rackmount solutions for defense applications, Mercury’s EnterpriseSeries servers have been deployed on over thirteen major Army programs in the last three years.
Built for interoperability, longevity, availability, and performance, Mercury’s platforms are employed in numerous Army applications including simulation and stimulation, radar signal processing, secure networking, battle command and control system processing, VICTORY enabled platform communications, and cyber operations.”
“We are proud to support our customer and the U.S. Army with solutions that deliver trusted performance while operating on the move,” said Scott Orton, Vice President and General Manager of Mercury’s Trusted Mission Solutions group.
“With a multitude of ground deployments, Mercury continues to develop server solutions that are specifically designed to meet computing, reliability, environmental, and security requirements found on the tactical edge.”
These technologies could be applied to other sectors and that could explain the stock’s long term performance.
A Trade for Short Term Bulls
As with the ownership of any stock, buying MRCY could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for MRCY
Every day, we scan the markets looking for trades that MRCY low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
For MRCY, the April 18 options allow a trader to gain exposure to the stock.
An April 18 $65 call option can be bought for about $1.35 and the April 18 $70 call could be sold for about $0.37. This trade would cost $0.98 to open, or $98 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $100.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in MRCY the maximum gain is $4.02 ($70 – $65 = $5; $5 – $0.98 = $4.02). This represents $402 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $98 to open this trade.
That is a potential gain of about 310% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.